In re Francis

November 10, 1998

IN RE: FRANK P. FRANCIS, ALSO KNOWN AS FRANCIS GENERAL CONSTRUCTION, DEBTOR. ED SCHORY & SONS, INC. AND ROBERT G. SCHORY, JR., PLAINTIFFS-APPELLEES,v.FRANK P. FRANCIS, ALSO KNOWN AS FRANCIS GENERAL CONSTRUCTION, DEFENDANT-APPELLANT.

Appeal from the United States Bankruptcy Court for the Northern District of Ohio, Eastern Division, at Canton. No. 97-61646.

Argued: September 2, 1998

COUNSEL

The Debtor, Frank P. Francis, has appealed the bankruptcy court's grant of summary judgment in favor of the Plaintiffs (Schory) in a nondischargeability action under § 523(a)(2)(A). The bankruptcy court determined that due to several prior state court decisions, collateral estoppel barred Francis from relitigating whether his debt resulted from his fraud. The Ohio Supreme Court had previously held that a letter in which Francis admitted that he had fraudulently misappropriated funds from Schory was substantially true. The bankruptcy court further determined that a prepetition settlement agreement between the parties did not operate as a novation which extinguished Schory's fraud claim for purposes of § 523(a)(2)(A).

The issue of novation in the context of § 523(a)(2)(A) is a novel issue in the Sixth Circuit. The Panel finds the reasoning of United States v. Spicer, 57 F.3d 1152 (D.C. Cir. 1995) persuasive, and holds that a general release as part of a tort settlement does not constitute a novation which extinguishes a creditor's fraud claim in the context of § 523(a)(2)(A). Furthermore, the bankruptcy court properly applied collateral estoppel. Accordingly, the Panel affirms the bankruptcy court's order finding that the debt is non-dischargeable.

I. ISSUES ON APPEAL

There are two issues on appeal. The first is whether the bankruptcy court erred in granting summary judgment on the basis of collateral estoppel. The second is whether the parties' prepetition settlement agreement operates as a novation that extinguishes Schory's nondischargeability claim under § 523(a)(2)(A), which did not exist at the time of the prepetition settlement agreement.

II. JURISDICTION AND STANDARD OF REVIEW

The Bankruptcy Appellate Panel of the Sixth Circuit has jurisdiction to decide this appeal. The United States District Court for the Northern District of Ohio has authorized appeals to the BAP. A "final order" of a bankruptcy court may be appealed by right under 28 U.S.C. §158(a)(1). For purposes of appeal, an order is final if it "ends the litigation on the merits and leaves nothing for the court to do but execute the judgment." Midland Asphalt Corp. v. United States, 489 U.S. 794, 798, 109 S. Ct. 1484, 1497, 103 L. Ed.2d 879 (1989) (citations omitted).

In 1987, Francis and Schory formed a partnership which ultimately resulted in litigation between the two parties. Schory filed a lawsuit against Francis alleging fraud, misrepresentation, and misappropriation of funds. Francis filed counterclaims. On March 14, 1991, the parties reached a settlement. Pursuant to the settlement agreement, Francis signed a cognovit note for $130,000 secured by a mortgage on Francis's real property. The parties agreed to release each other from all claims relating to the litigation.

Ultimately, Francis defaulted on the cognovit note and Schory filed a foreclosure action against the real property securing the note. The parties eventually entered into an amended settlement agreement on March 2, 1991. The following letter dated May 1, 1991, was attached to the settlement agreement:

"Dear Bob:"

"I am sincerely sorry for all the grief and aggravation I have caused you and your family. I acknowledge by this letter that I fraudulently misappropriated the sum of $370,000 from the Arlington General Partnership on the Arlington Road and Whipple Avenue Projects. This was done by knowingly misrepresenting the construction expenses of Francis General Construction, Inc. I regret any problems which I may have caused your family and your business. I also apologize for filing the counterclaim and calling the police."

Francis defaulted on the amended settlement agreement, and Schory again filed a foreclosure action. Francis filed a counterclaim asserting that he had been coerced into signing the letter and that Schory had defamed him by showing the letter to others.

The Ohio Court of Common Pleas granted summary judgment in favor of Schory on all of Francis's claims. Francis appealed to the Ohio Court of Appeals, which affirmed the trial court's decision that there was no defamation because the admissions in the letter were "substantially true." Francis appealed to the Ohio Supreme Court, which affirmed the judgment of the Court of Appeals on the basis that truth is an absolute defense to defamation and the letter was true. Ed Schory & Sons. v. Francis, 662 N.E.2d 1074 (Ohio 1996).

On May 30, 1997, Francis filed a petition under Chapter 7 of the Bankruptcy Code. Schory filed an adversary proceeding for a determination that the debt is non-dischargeable under 11 U.S.C. §§ 523(a)(2)(A) and (a)(4). The bankruptcy court applied collateral estoppel and determined that the debt was non-dischargeable under § 523(a)(2)(A) based on Francis's admissions in his letter of May 1, 1991. Francis appealed.

IV. DISCUSSION

A. The bankruptcy court properly applied collateral estoppel in determining that the debt is non-dischargeable under § 523(a)(2)(A) due to Francis's fraud.

The bankruptcy court held that the principle of collateral estoppel bound the court to follow findings of the state courts that Francis's admission of fraud was substantially true. Therefore, the bankruptcy court granted summary judgment, holding the debt non-dischargeable under § 523(a)(2)(A).

Collateral estoppel requires "that `the determination of a factual or legal issue in a judgment is conclusive in subsequent litigation if it was "actually litigated and determined," and the determination was essential to the judgment.'" Corzin v. Fordu (In re Fordu), 209 B.R. 854, 862 (B.A.P. 6th Cir. 1997) (quoting Shelar v. Shelar, 910 F. Supp. 1307, 1312 (N.D. Ohio 1995)). The Sixth Circuit has held that the application of collateral estoppel in a nondischargeability action depends upon whether the applicable state law would give collateral estoppel effect to the judgment. Bay Area Factors v. Calvert (In re Calvert), 105 F.3d 315 (6th Cir. 1997).

In order to successfully assert collateral estoppel under Ohio law, a party must plead and prove the following elements: (1) the party against whom estoppel is sought was a party or in privity with a party to the prior action; (2) there was a final judgment on the merits in the previous case after a full and fair opportunity to litigate the issue; (3) the issue must have been admitted or actually tried and decided and must be necessary to the final judgment; and (4) the issue must have been identical to the issue involved in the prior suit. See Parklane Hosiery Co. v. Shore, 439 U.S. 322, 326, 99 S. Ct. 645, 649, 58 L.Ed.2d 552 (1979).

The first element is clearly met in this case, as the adversary proceeding involved the same parties as ...

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